THURSDAY, March 28, 2024
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Multiple approaches to credible valuation

Multiple approaches to credible valuation

When we discuss the valuation of business or shares or assets, most professionals who have been working in finance and banking and the financial community would understand how it works.

But when we start discussing the details of each valuation approach, differences and departures seem to be unavoidable. There are generally three approaches in valuation: income approach (discounted cash flow or DCF), market approach (market multiple) and asset-based approach. Each approach has pros and cons, but generally they are all useful when assessing the value of a business or asset. 
The DCF relies on future forecast assumptions as well as the appropriate discount rate used. Deriving the cash-flow forecast depends on the business assumptions, which are influenced by both internal and external factors on a business. The discount rate, which is derived from the same theoretical formula – CAPM (capital asset pricing model) – can be different subject to the input factors. Many practitioners might use input factors such as “beta” from different reference sources. Some may apply historical 10-year market returns while others may use 15 years. Some debate if debt-to-equity ratio from book value should be used rather than market debt-to-equity ratio from a set of comparable companies. It is not surprising that the valuation results prepared by different professionals can be wide apart. 
In the international markets, there are two standards that most practitioners follow when it comes to valuation – International Financial Reporting Standards (IFRS 13: Fair Value Measurement) and International Valuation Standards (IVS). The IFRS 13 is the standard for financial reporting purposes when assessing the “fair value” while the IVS covers broadervaluation uses. However, both standards, have the same purpose – to build public trust bypromoting transparency and consistency invaluation practice. 
Below are highlights of the concepts and approaches of the two standards. 
IFRS 13: Fair Value (FV) is “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date”.
FV measurement assumes that the transaction take place in either the principal market, and in the absence of principal the most advantageous market. The standard indicates an entity must determine the following to derive measurement of fair value:
The principal (or most advantageous)market in which an orderly transaction would take place. The highest and best use of the asset for non-financial assets. The valuation techniques for an entity to use in measuring fair value focus on inputs a market participant would use in pricing the assets.
The three most widely used valuation techniques are: market approach, cost approach and income approach. An entity shall use valuation techniques consistent with one or more of those approaches to measure fair value. 
The standard establishes fair value hierarchy. Its gives the highest priority to quoted prices (Level 1), inputs other than quoted prices that are observable (Level 2) – the quoted price for similar assets, and unobservable inputs (Level 3) for assets. 
Level 1: A quoted price in an active market provides the most reliable evidence of fair value and will be used without adjustment tomeasure fair value whenever available. 
Level 2: Inputs are other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. 
Level 3: Unobservable inputs will be used to measure fair value to the extent that relevant observable inputs are not available; there is little market activity for the asset or liability. Therefore, unobservable inputs shall reflect the assumptions that market participants would use when pricing the asset or liability, including assumptions about risk. 
IVS: Market Value is “the estimated amount for which an asset or liability should be exchanged on thevaluation date between a willing buyer and a willing seller in an arm’slength transaction, after proper marketing, and where the parties had each acted knowledgeably, prudently and without compulsion.
It is the best price reasonably obtainable by the seller and the most advantageous price reasonably obtainable by the buyer.
A “willing buyer” refers to one who is motivated, but not compelled to buy, and a “willing seller” is neither an over eager nor a forced seller prepared to sell at any price.
“After proper marketing” means the asset has been exposed to the market in the most appropriate manner to affect its disposal at the best price reasonably obtainable.
The Market Value of an asset will reflect its highest and best use. The highest and best use is the use of an asset that maximises its potential and that is possible.
Market Value does not reflect the attributes of an asset that are of value to a specific owner or purchaser, which are not available to other buyers in the market.
The principal valuation approaches are:(a) market approach, (b) income approach, and (c) cost approach. 
Valuers are not required to use more than one method for the valuation of an asset,particularly when the valuer has a high degree of confidence in the accuracy and reliability of a single method, given the facts and circumstances of the valuation engagement. However, valuers should consider the use of multiple approaches and methods and more than one valuation approach or method should be considered and may be used to arrive at an indication of value.

Observations
The definition of fair value and market value as described under the two standards have a similar meaning. Both specify that it is the value in the view of market participants and not the value to a specific investor or buyer. The market participants are willing buyers and willing sellers who are knowledgeable, understand the assets, and are willing and motivated to enter into the transaction but not forced to do so. 
The definition is important and is the starting point when practitioners prepare the valuation using different techniques.  As observed in the market practice, some practitioners factor in potential synergies in performing the valuation exercise. IFRS 13 does not do so if market participants do not foresee the synergies. Under IVS, if a specific synergy is factored into thevaluation, the result does not represent “Market Value” but rather an “Investment Value”.
Although, both standards allow the use of the same valuation techniques, IFRS 13 clearly defines priority of valuation in assessing the fair value. Level 1 is the trading price of an asset in the market (stock market) and if there is no such trading price, the Level 2, market comparable approach, will be used.
In case there is no market comparable, Level 3 is then applied. Level 3 usually refers to the discounted cash flow approach where business assumptions are reflected into the valuation model.
It is important to note that the assumptions used in Level 3 are those anticipated by market participants not specific to an investor/buyer. The discount used shall also reflect the related risk of market participants.
On the other hand, IVS is more flexible on valuation techniques used. Practitioners can use several valuation approaches as appropriate under those circumstances. However, the conฌcept of market participants is still the same if market value is to be assessed.
Both standards have more detailed guideฌlines in assessing fair value or market value and are useful for practitioners, executives, investors, and those who use financial statements and valuation reports. Unfortunately, the Thaimarket only adopts IFRS 13, the socalled Thai Financial Reporting Standard (TFRS 13), which is consistent with the IFRS 13. Hopefully, in the near future, the Thai market will also adopt the IVS or establish its owned valuation standards.

Contributed by Thavee Thaveesangsakulthai, Partner, Financial Advisory, Deloitte
 

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